Naming who should get the life insurance money after you die
sounds simple, but designating beneficiaries can get tricky.
Mistakes are common, financial advisers say -- and they can be
heartbreaking and expensive.
When mistakes are made "you're not creating problems for you,"
says Keith Friedman, principal of FBO Strategies, an estate
planning and insurance firm in Stamford, Conn. "You're creating
problems for the people you leave behind."
Here are 10 life insurance beneficiary mistakes to avoid.
1. Naming a minor child
Life insurance companies won't pay the proceeds directly to
minors. If you haven't created a trust or made any legal
arrangements for someone to manage the money, the court will
appoint a guardian, a costly process, to handle the proceeds until
the child reaches 18 or 21, depending on the state.
Instead, you can leave the money for the child's benefit to a
reliable adult; set up a trust to benefit the child and name the
trust as the beneficiary of the policy; or name an adult custodian
for the life insurance proceeds under the Uniform Transfers to
Minor Act. Consult an estate attorney to decide the best
2. Making a dependent ineligible for government benefits
Naming a lifelong dependent, such as a child with special needs,
as beneficiary puts the loved one at risk for losing eligibility
for government assistance. Anyone who receives a gift or
inheritance of more than $2,000 is disqualified for Supplemental
Security Income and Medicaid, under federal law.
Work with an attorney to set up a special needs trust, and name
the trust as beneficiary. A trustee you appoint will manage the
money for the dependent's benefit.
Here's more on
life insurance planning for parents of children
with special needs
3. Overlooking your spouse in a community-property state
Generally you can name anyone with whom you have a relationship
as beneficiary, even a secret lover.
"Life insurance is not a judge of someone's morals," Friedman
However, in community-property states, your spouse typically
would have to sign a form waiving rights to the money if you
designate anyone else as beneficiary. Community-property states
- New Mexico
4. Falling into a tax trap
Life insurance death benefits are generally tax-free --
when three different people play the roles of policy owner, the
insured and the beneficiary. In that case, the death benefit could
count as a taxable gift to the beneficiary, says Amy Rose Herrick,
a Chartered Financial Consultant and life insurance agent with
offices in the U.S. Virgin Islands and Tecumseh, Kan.
Say, for instance, a wife owns a life insurance policy on her
husband's life and names their adult daughter as beneficiary. The
wife effectively is creating a gift of the policy proceeds to her
daughter, Herrick says. The person who makes the gift -- the wife
-- is the one who would be subject to the tax, if the amount of the
gift exceeds federal limits.
The problem could be avoided in most cases by having the husband
own the policy, insuring himself. However the situation can get
tricky in community-property states. Consult a financial adviser to
decide the best way to structure the policy.
5. Assuming your will trumps the policy
A life insurance policy is a contract. Regardless of what your
will says, the life insurance money will be paid to the beneficiary
listed on the policy. That's why it's important to contact your
insurer to change your beneficiary if needed.
See more information on
wills vs. life insurance policies: Who's the
6. Forgetting to update
"Designating beneficiaries are not 'set it and forget it'
events," says Tara Reynolds, vice president at MassMutual. You
should review your policy every three years and after major life
events, such as marriage, having children or divorce. Change the
beneficiaries when circumstances change.
Unfortunately, many people forget to do so.
"Half of my practice is second or third marriages," says Peter
Blatt, a tax attorney and financial adviser in Palm Beach Gardens,
Fla. "It's not uncommon to find the ex-spouse still listed as
beneficiary on the life insurance policy" when reviewing a client's
7. Neglecting details
By branch or by person?
You want to leave life insurance money to your kids and
grandkids, and you want it divided evenly.
There are two ways of distributing the money -- per
stirpes and per capita. You can specify either method on
the life insurance policy, and both are acceptable options
when naming beneficiaries, says Ed Graves, a professor of
insurance for The American College in Bryn Mawr, Pa. "But
the possible outcomes can be drastically different from one
approach to the other."
Per stirpes means the proceeds are divided by branch of
the family, and per capita means they are divided by
Say, for instance, you want to leave the money to your
two children, Bob and Sue, or to your grandchildren if Bob
or Sue predeceases you. Bob has three children and Sue has
one child. Now suppose Bob dies before you do.
Under per stirpes, half the money would go to Bob's
three children, and half would go to Sue. Under per capita,
the money would be divided equally among Bob's three
children and Sue; each would get 25 percent.
Choose the distribution method to match your intentions.
Graves recommends you diagram the possible scenarios.
"Complex situations should probably have an attorney
involved," he adds.
Be specific when you name beneficiaries. Instead of "my
children," list their names, Social Security numbers and addresses,
says Ed Graves, a professor of insurance at The American College in
Bryn Mawr, Pa.
Otherwise, "the insurance company has to launch a search and
that can take a lot of time," Graves says.
When naming multiple beneficiaries, decide whether you want the
money divided "per stirpes," which means by branch of the family,
or per capita, which means by head. (See sidebar.)
8. Staying mum
"The most important thing is to tell someone so they know you
have a life insurance policy, where it is and how to find it," says
Joshua Hazelwood, vice president at MassMutual.
Open communication with beneficiaries now can save a family from
chaos later - or even worse, never claiming the benefit.
9. Giving money with no strings attached
Naming your young-adult children as beneficiaries without
setting any conditions for how the money is dispersed can be a
setup for financial failure. How many 18- or 21-year-olds can
handle a huge influx of cash? One way is to set up a trust with
specifics for how the money can be released and what it can be used
for until the young adult reaches a certain age.
"It allows me as a parent to instill what I feel is valued in my
absence," Friedman says. "I don't want to leave my children with
millions of dollars when they're 18 with unfettered access."
Insurers are beginning to introduce policies that let you
arrange for the death benefit to be paid out in installments.
Minnesota Life Insurance Co.'s new indexed universal life product,
Omega Builder IUL, includes that option, calling it an "income
10. Naming only a primary beneficiary
"Most people just think they're going to make their spouse
beneficiary, but don't take into account the spouse might
predecease them," Friedman says. "It's conceivable that something
would happen to you and your spouse together."
Blatt says he even sees cases where people fail to name any
beneficiaries. When there is no living beneficiary, the life
insurance benefit typically goes into the estate and is subject to
probate. That leads to two complications. One, heirs might face a
long wait to get the money. Two, the life insurance proceeds, which
normally would be protected from creditors, now can be used to pay
Advisers recommend naming secondary and final beneficiaries. If
the primary beneficiary dies before you do, then the money passes
to the secondary beneficiary. If the secondary beneficiary has
passed away when you die, then the death benefit goes to the final